You will probably see Silicon Valley’s Sand Hill Road, center of the nation’s venture capital industry, turn to the right during the next elections.
Senator Hillary Rodham Clinton has just become the last of the main three Democratic presidential candidates to announce her support for ending a tax break that has enabled venture capitalists and other investors to enjoy taxes of 15 percent on their profits, instead of the income tax level of 35 percent.
We’ve covered this story as it has developed. Congress is considering passing legislation to end the break.
“Don’t get me wrong,” she was quoted in today’s NYT as saying in New Hampshire, in response to a question about whether this would harm the support of entrepreneurship. “Private equity and venture capital play important roles in our economy, and we should continue to support the entrepreneurial spirit that makes America great.”
But she went on, “We can close this loophole that unfairly benefits some of the best-paid people in America, while continuing to encourage investment in innovative, young companies.”
VC Kate Mitchell has argued that VCs are putting their money at risk along with the entrepreneur, citing her own example: She has invested her own savings into start-ups, and then waits many years for returns that may or may not come. The shortcoming to this argument, of course, is that alongside her own money, she is also investing money her firm gets from institutional investors. She partakes of profits returned on both her own savings and on this other institutional money that is not hers. [Update: Indeed, the VC tax being discussed would be applied to this latter portion, and so her argument about her own savings may be irrelevant, as the commenter below suggests. We're checking the details on this.]
Mitchell also argues VCs are different from buyout and other investors, in that VCs support entrepreneurship and nurture young companies that tend to add jobs and contribute to economic expansion.
Update: Oh, and look at what buyout firm Blackstone is doing. Effectively, avoiding paying $3.7 billion in taxes. Makes the head hurt.
Tags: inv:Blackstone6 Comments
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wtf said:
Kate Mitchell’s point is irrelevant and disingenuous. No one is suggesting that the income tax rate applies to (the portion of profits from) her personal investment in the fund.
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Marshall Kirkpatrick said:
I read PEHub almost daily and the best I can gather from my shallow understanding is that my understanding is shallow and this is a VERY complicated issue. I’d love to read a good, accessible 101 on this debate.
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Hugh J. Sloan III said:
Someone get Jerry Brown on the horn…I understand that a VC Tax violates some ancient Tibetan law and I am prepared to start collecting signatures to write him in if its not to late. Both Robespierre and Marat, have also weighed-in squarely against the VC tax, at least thats what my people are telling me. Most of us are fond of keeping our fourth residences on Broadway Terrace and not, a priori, turning them over to the Sans-culottes without a good patrician fight!
Please see Anatole France, Les Dieux ont Soif, for a blow by blow account of the last time the VC tax was introducted in the French Republic.
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noob said:
Interesting… So, the many far-left leaning VC’s really aren’t motivated by the real liberal and social issues that they vocalize about. Instead, they’re more interested in their money?
So, VC’s are just like anyone else: money IS more important than societal issues.
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Joe said:
I am very interested in the outcome of this debate and logically believe that carried interest, whether it be a VC firm or a PE firm or a similar partnership, should pay ordinary income taxes. I am from the VC oriented tech community with both business and engineering experience. BS/MS EE + Harvard MBA
Here is my simple but logical reasoning. I am not a legal expert nor a tax expert, so I am going from “first principles”
1) A VC or PE partnership’s job is to manage money. They invest other people’s money. This is essentially a passive investment. they don’t start companies or run them, or design products or invent things, or make and sell products. They are simply an investment vehicle for other’s money.
2) Given the above, then what they get paid for doing that job is simply a salary. Nothing else. The fee is their base pay and the carry is their performance bonus.
3) If the investment results in a capital gain i.e. a start up company goes public or sold or a PE company gets sold then this gain which should be treated as Capital Gains must go to the investor who risked that capital. The investors who risked their capital are the LPs.
4) Therefore, only logical person or entity that can get the Capital Gains treatment is the actual source of money - i.e. the endowment or the pension fund or any other LP.
5) Definitely not the Fund-of-Funds. They are simply middlemen or brokers or intermediaries. The partners put none of their capital at risk
6) The only other people who get Capital Gains treatment are the Founders / Management who purchase low priced stock (or have options to do so) and risk their career and salary to build or fix a company.
7) Therefore the actual sources of money and the Founders / Management / Employees who own equity must get the capital gains treatment. This is critical and vital for the economy and for growth and for motivation to “fix ailing companies” i.e. that the sources of investment and the employee-owners get Capital Gains treatment. The middlemen or the “intermediaries” to use Warren Buffet’s term should simply get ordinary income (salary and bonus).
8) The intermediaries (VC and PE GPs) can invest their personal money in a company and get a capital gains treatment. They cannot invest OPM and get capital gains treatment. In this structure, they are also LPs. And the return on their LP investment can and should get Capital Gains treatment.
In the above logical and economically, socially and morally correct reasoning, there will be no dearth of funding sources. The actual people or entities with the money - i.e. the real LPs are still motivated to make risky investments. Just not with greedy “used car salesmen” as the middlemen. There are plenty others with good qualifications who will gladly be the middlemen without a Capital Gains treatment of the carry, as the source of these funds are motivated to invest and the world has a ton of educated professionals who will settle for a high salary and very large bonus, even if it is not Capital Gains.
These new managers will be working for the real investors on a salary and bonus which by any stretch of the imagination is very lucrative. Therefore, there will be highly qualified takers. This is a competitive world.
In summary the government will receive extra funds from the elimination of Capital Gains treatment of the carry and should
a) Reduce Capital Gains to 10% for the real source of money and for real equity holders such as employees / founders / management
b) Tax the salary and carry as ordinary income. This extra tax will pay for the reduced Capital Gains
Thank you
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Steve said:
Well stated, Joe. This whole issue has nothing to do with cap-gains taxes on true at-risk investments. It’s simply about closing a loophole that lets VCs and hedge-fund mangers pay 15% on their ordinary income while everyone else pays over 30% PLUS payroll tax. (Here’s a question: Do VCs pay payroll tax on any of their income?) Two VCs I talked to in the last month actually seemed embarrassed by the “we’re strengthening America” defense a few of their fellow VCs are presenting for this obvious bit of money-manager welfare.
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VentureBeat » Why VCs should pay the higher tax — and an example said:
[...] Here’s why we think venture capitalists and other investment professionals should pay income tax rates on “carried” profits, as proposed by legislation in Washington. [...]